This paper applies the technique for valuing compound options to the risky coupon, bond problem. A formula is derived which contains n-dimensional multivariate normal intecjrals. It is shown that, for some compound option problems, the special correlation structure allows an application of an integral reduction which may simplify the numerical evaluation. The effects of various indenture restrictions on the formula are discussed, and a new formula for evaluating subordinated debt is presented.

Looking back over the last two decades, financial economists can find considerable cause for pride and self-congratulation in the development of their discipline. From the earliest steps toward a rigorous theory of capital budgeting, through the Modigliani-Miller theorems on corporate financing and cost of capital, to the development of the capital asset pricing theory, the field of finance has garnered a well-deserved reputation for rigor, analytic sophistication, and pace of intellectual growth.

In a world where individuals are assumed to receive new information about an asset in random and sequential order, the volume of trading for a given message is a random variable. If the probabilities of trading events can be specified, it is possible to develop closed form expressions for the expected number of trades and the variance of trading. The result is a theory of trading which relates the number of trades to the characteristics of the message and to the number of participants in the market for an asset.

In recent financial literature a large volume of the articles dealt with asset leasing. This author and his colleagues [6] and others [7] developed the conditions under which asset leasing cannot increase the overall firm's value over normal debt leverage. Many others [2, 3, 11] analyzed the “lease-buy” decision using a variety of models and assumptions. None, however, considered the effect of asset leasing on the firm's capitalization rate. While asset leasing per se would not affect the firm's unlevered cost of capital, it should affect its estimation. This paper developed the adjustment factor to obtain the firm's corresponding unlevered cost of capital with leasing leverage. Basically, Modigliani and Miller's methodology [9] was adjusted for the different tax situation with asset leasing. The effective benefit of leasing on the firm's average cost of funds was shown to be not nearly as effective as an equivalent amount of ordinary debt.

The financial dilemmas faced by large municipalities, due in general to decreasing tax bases, increasing public services, inflationary pressure and in some cases fiscal irresponsibility, have brought increased attention to the subject of municipal bond ratings. In order to gain insight into those factors which are most significant in explaining the ratings, a set of financial ratios is investigated. Such ratios are frequently used to describe characteristics of the risk of municipal obligations. This paper attempts to determine if these ratios can be effectively used to predict ratings.

In contrast with the normal undergraduate or graduate level course in international finance discussed by the other panelists in this session, the international financial material covered in the Masters in International Business Studies (MIBS) program at the University of South Carolina is not tightly collected into one segment, but rather is disaggregated and reintegrated into a larger curriculum design. In this degree program, designed specifically for the entry level training of personnel with aspirations for multinational responsibility, all business education (with the exception of a secondyear planning-policy course) is integrated into one large “megacourse,” the Unified Business Program. Within this megacourse, specific learning objectives have been developed and individual learning segments, many drawing on faculty and concepts from different disciplines, have been designed to meet these learning objectives. Material traditionally covered in an international finance course forms a portion of a number of these segments, and it is the purpose of this paper to outline how this material is integrated into the main flow of the program.

A review of the textbooks and syllabi used in courses on international financial management in several Eastern and Midwestern business schools reveals the existence of a number of common topics but substantial differences in the relative emphasis accorded to issues. Some concentrate on the financial and foreign exchange markets and on exchange rate forecasting; some on the measurement and hedging of exposure; some on the financing of international transactions; some on international accounting and control; and some on portfolio theory and capital market issues. Why do they differ? In part, because the educational objectives of institutions are different, some being much more practiceoriented than others. The M.B.A. students at Chicago, for example, are much more willing to engage in a theoretical discussion than are those at Columbia, who have a stronger decision-making orientation. Other differences arise from the pedagogical approach–the heavy use of cases, for example, tends to require a concentration on applicable techniques.

In planning any finance course an important consideration is its economic content. After all, financial decisions are invariably made in the context of both micro and macro uncertainty. The micro issues are often given extensive coverage in the form of models that optimize returns, cash flows, or credit choices, and the techniques needed to produce the required input for those models: ratio analysis, proforma statement preparation, and valuation frameworks such as the capital asset pricing model. Yet, the macro uncertainty is very often assumed away.

International finance has developed into a recognized field of study within the broader discipline of international business. This has occurred because increasing commitments of companies to international operations have forced more and more financial managers to face a number of problems and issues not found in a strictly domestic setting. Foreign currency exchange risks, exchange controls, restrictions on the flow of funds, diverse accounting and taxation systems, host government interference, and the effects of worldwide inflation on enterprise assets, earnings, and capital costs are just a sample of the variables calling for specialized knowledge.

The focus of this study is the role of default risk in capital market theory. The impact of default risk on the value of securities has been a major concern of investors and academics alike. Several authors have examined the relationship between bond ratings, the probability of default, and security value [5, 12]. In this context, the ability to avoid or reduce expected bankruptcy costs and thereby increase value has been suggested as a reason for mergers and consolidations [16, 18]. In other studies, models have been developed for predicting ratings [17, 20, 21, 28], for predicting bankruptcy using accounting and other financial variables [1, 6, 7], and for approximating default premiums in the credit markets [22]. Finally a question which has received considerable attention is the effect of bankruptcy on a company's cost of capital. When bankruptcy is possible and there exists a positive bankruptcy transaction cost, it has been argued that there is an optimal capital structure [24, 26].

The paper derives a general form of the term structure of interest rates. The following assumptions are made: (A1) The instantaneous (spot) interest rate follows a diffusion process; (A2) the price of a discount bond depends only on the spot rate over its term; and (A3) the market is efficient. Under these assumptions, it is shown by means of an arbitrage argument that the expected rate of return on any bond in excess of the spot rate is proportional to its standard deviation.

This paper extends the results of previous work by the author in the development of a structure for analysis of rather general two-currency decision problems using an nstage dynamic programming model. After a brief review of the model, the paper provides a characterization of a convertibility scheme as a set function which assigns to each currency portfolio a set of currency portfolios which can be attained from the original portfolio, operating through the convertibility scheme. The concept of a substitutable convertibility scheme is developed; the substitutability property allows the decision maker to substitute a functionally determined single currecy payoff for a given twocurrency payoff. Two tests to determine substitutability in general, and for a particular return function, are developed. The modest reduction in dimensionality of the dynamic programming problem arising from this property is explained. Some specific convertibility schemes are then characterized, including free convertibility, inconvertibility, retention quotas, maximum balance, maximum acquisition, and multiple rate schemes. The substitutability of free convertibility is demonstrated. A retention quota scheme which allows free sale and purchase of retained funds in a parallel market is shown to be equivalent to a free convertibility scheme, and therefore substitutable.

This paper examines the profitability and risk of a naive strategy of forward exchange speculation during pegged and flexible exchange rate systems. It suggests a new method of calculating these speculative returns and shows that the average return was much less than previously supposed and that the distribution of returns differed between systems and countries.

Some basic ideas of a model of the international term structure of interest rates are outlined. Based on Roll's (1970) theory of equilibrium interest rates in an efficient bond market of a closed economy, we show that the term structure of interest rates in countries whose residents engage in international financial transactions is a function of domestic and foreign traders' expectations of future domestic and foreign spot interest rates, or their degree of risk aversion, and of differences in time preferences.

In this paper, we develop a Capital Asset Pricing Model (CAPM) using a mean-lower partial moment framework. We explicitly derive the valuation formulas for the equilibrium value of risky assets and provide a distribution-free testable hypothesis for empirical validation of the new CAPM. We show the invariance of our results to the problem of estimation risk. We also show that when the probability distribution of security rer turns is the normal distribution, the stable Paretian distribution (with the same characteristic exponent between 1 and 2 and the same skewness parameter (not necessarily zero)), or the multivariate t-distribution, our CAPM reduces to the traditional two-parameter CAPM.

This paper utilizes a two-parameter model of segmented securities markets to develop equilibrium implications concerning the impact of statutory investment restrictions upon the market prices and allocation of risky securities. The distinguishing feature of the model is the existence of a subset of securities common to the opportunities of all investors and therefore said to “span” the investor population. These common opportunities are shown to permit intersubset security transactions which integrate the various market segments and lead to the following theorem and tendency concerning equilibrium prices and portfolios:

Theorem: In the absence of active barriers against short positions, the equilibrium expected return for any security spanning the investor population is an exact linear function of its contribution to total market risk, irrespective of the number of distinct investor segments that may exist.

Tendency: The economic characteristics of the equilibrium risky portfolio for any investor, irrespective of the market segment to which he or she may belong, will approximate the characteristics of the market portfolio of all risky assets in the economy in all relevant risk dimensions.

This paper examines the problem of the selection of first-, second-, and thirddegree undominated portfolios by using the properties of the Laplace transform (L-T) of the distributions of portfolio returns. It is assumed that the joint distribution of n interdependent prospects, as well as its Laplace transform, is known or may be estimated from past data. Next, it is shown that the L-T of the portfolio returns may be expressed very simply in terms of the L-T of the joint distribution. A theorem is then proved, which uses results from L-T theory and shows that stochastic dominance between two portfolios of first-, second- or third-degree may be expressed by inequalities between the L-T's of the portfolios and their derivatives. It is also shown through an example how this theorem may be used in finding undominated portfolios.

The author argues, in this paper, that there are at least three reasons why a simultaneous equation bias may exist and be significant in single equation estimates of executive compensation when one of the independent variables is a measure of firm performance. First, there is simultaneity between the determination of the MRP of the executive input and profit maximizing output in the classical microeconomic sense. Second, where firm performance is used as a measure of executive quality, then a simultaneous bias may develop. Third, the presence of expense preference behavior could result in simultaneous but inverse effects on executive compensation and firm performance.

The paper presents evidence suggesting that banks with very low and very high capital positions respond to interest rate changes differently from other banks. The concept of a capital constraint is introduced to explain this phenomenon. The hypothesis is that banks with a binding capital constraint should exhibit different asset management decisions from those banks which are unconstrained. The regression results indicate that low-capital banks for the years 1973-74 and 1974-75 did not respond to earnings in an economic fashion.

During 1976 and 1977, a national sample of nearly 300 FDIC-insured financial institutions had their applications for home mortgage and home improvement loans monitored. The purpose of the study was to establish whether, and in what form, discrimination existed in the granting of housing-related loans.